Investing.com – Federal Reserve Chair Jerome Powell is navigating familiar territory as he heads into 2025, aiming to balance central bank independence while avoiding a showdown with Donald Trump.
Powell's challenge is to manage monetary policy without appearing to preemptively confront potential inflationary pressures from the incoming administration's policies.
The balance has been evident in recent months. Shortly after Trump won the election in November, Powell emphasized that the Fed would not speculate on how future policies would affect interest rates.
“We don't guess, we don't speculate, we don't assume,” Powell said on November 7. However, the Fed's latest forecasts suggest that some officials are already considering policy changes, suggesting fewer interest rate cuts in 2025 due to inflation concerns.
Last week, the Fed cut interest rates by a quarter of a percentage point, completing a full percentage point cut since September. However, the updated forecasts revealed a more cautious stance on monetary easing.
Most officials now expect only two cuts next year, down from four expected in September. Inflation is expected to remain at 2.5% in 2025, up from the previous forecast of 2.2%. Notably, 15 out of 19 Fed officials see a risk that inflation could exceed expectations.
Michael Gapen, chief US economist at… Morgan Stanley (NYSE:), has noticed this shift. The last meeting “was much more stringent than we thought because they did what they said they wouldn't do: They said they wouldn't speculate on policies, and then a month later they decided to speculate on policies.” He said.
The main factor behind this caution is Trump's proposed economic agenda, which includes tariffs and tougher immigration policies. Tariffs could lead to higher prices, while stricter border controls could restrict the supply of labor, leading to higher wages. Powell downplayed the direct impact of Trump's election on inflation expectations, attributing the shift to recent inflation data instead.
Despite this, Powell, according to the Wall Street Journal, has privately advised his colleagues to tread carefully in their public statements to avoid perceptions of political bias. This approach is consistent with Powell's efforts to maintain the Fed's reputation for non-political, data-driven decision-making.
The risks are high. Powell recalls the Fed's experience during Trump's first term when trade wars drove down interest rates. However, the current environment is different. Inflation has risen, in contrast to the backdrop of low inflation in 2018. Powell highlighted this distinction in his December 18 news conference, pointing to the Fed's previous internal analyses.
“What the committee is doing now is discussing the pathways and understanding the ways in which tariffs could impact inflation and the economy again,” Powell said. “It puts us in a position, when we finally see what the actual policies are, to make a more careful and thoughtful assessment of what might be the appropriate policy response.”
Trump's advisers claim that deregulation and increased energy production could offset inflationary risks. Treasurer-designate Scott Besent played down concerns.
“Tariffs cannot be inflationary because if the price of one thing goes up, unless you give people more money, they will have less money to spend on the other thing, so there is no inflation,” he said on a radio show he hosted. By Larry Kudlow, former Trump advisor.
However, analysts believe the Fed will respond cautiously if improvements are reversed on the supply side.
“In this environment, you can't come out of six years of below-target inflation. You're back from a few years of being well above target,” says Michael Feroli, chief economist at JP Morgan.
Other analysts point out that the economic environment will greatly influence the extent to which companies pass on increased costs to consumers.
Economist Ray Faris believes that with full employment, cost increases are more likely to be passed on than in a recession. It also highlights the uncertainty over how quickly companies can adjust prices, explaining that gradual increases can make inflation appear firmer to the public.
